The Chinese Politics Of The Chem China - Syngenta Deal

Summary

ChemChina's $43 billion bid for Syngenta is likely to be approved at the highest levels within China.

But there are significant roadblocks both politically and financially.

Competitor Sinochem's Chairman has tight connections with the leadership and may want to participate, slowing approvals from CFIUS.

In August, the U.S. approved China National Chemical Corp.'s proposed $43 billion takeover of Swiss seed company Syngenta AG, overcoming domestic opposition on security grounds. Given the history of Chinese foreign acquisitions, one of the concerns remains the ability of ChemChina to raise the funds for the proposed purchase.

We think that there is senior government support for the transaction. But given Sinochem's chairman's close ties to the government, and his vast experience internationally, Sinochem may try to join either before or after the offer, in order to forestall the potential for ChemChina becoming a global leader.

1. Chinese Precedents. One of the plans under discussion is that Chinachem, Sinochem and an unknown third party will together invest in an initial SPV (Special Purpose Vehicle) for Chinachem's acquisition of Syngenta with an estimated total amount of US$15bn. Although both companies - along their subsidiaries - denied this speculation, the market believes this deal is a replay of the merger between CNR and China South Locomotive as well as China COSCO and China Shipping Group. These, however, were domestic, not international, mergers.

2. Equity Financing from a Government Fund. There is also speculation that Chinachem is also considering a new financing structure (equity financing). The major source will be provided by SASAC and the Silk Road fund for US$10bn. This is highly unlikely. SASAC is a regulatory agency with no real power or capital and the Silk Road Fund concentrates on deals in the region, not the U.S. This is also too large for the fund.

3. Possible All Cash Offer. Some analysts think Chinachem will first do some restructuring to lower the leverage given a high debt ratio of 80%. By the end of 1H16, Chinachem had a total debt over Rmb300bn. The acquisition (US$43bn) of Syngenta would also feature significant leverage, including a three-layer financing structure, with Chinese and international components, including six SVPs. However, bankers in China claim that Chinachem has already clarified the source of capital for this acquisition in its tender offer: "This is a cash offer and has nothing to do with Chinachem and its subsidiaries' financials," one banker told us.

4. Anti-Monopoly Investigation. The U.S. CFIUS approval may need to be revisited due to a potential cooperation between Chinachem and Sinochem. According to one Chinese mergers lawyer, "If the integration between Chinachem and Sinochem started before the acquisition, the recently approved anti-monopoly investigation may need to be redone, given the changes that happened in the agreement. It will be harder to get approval by CFIUS this time as the agrochemical and chemical businesses of Sinochem will be included this time. Before, Chinachem and Syngenta have few overlapping in terms of agrochemical and seed businesses."

5. Anti-Gene Transplant Sentiment Within China. Chinachem's acquisition of Syngenta was delayed for the third time, mainly due to Syngenta's transgenic technology. From the very beginning, the former head of the State Ministry of Chemical Industry and an additional 400 people petitioned against the acquisition. According to the media, this number has grown to more than 1,300. However, we are skeptical that these groups command much power in China given the emphasis by President Xi Jinping on creating global state giants.

6. Preferred Stock is One Option. Since 2006, Chinachem has conducted a few overseas acquisitions, which almost eliminated its cash flow. This time, Chinachem plans to sell preferred stock and bonds to raise money. According to CITIC bank, the first-layer capital raising of US$12.7bn was successfully completed in June, 20% more than expected. However, CITIC bank has been silent regarding the second-round financing.

Someone familiar with the acquisition told media that Chinachem was going to sell the preferred stock in one of its units in exchange for US$10bn, of which half of the preferred stock would be convertibles. The remainder consists of bank loans. The bank connections are worrisome. Usually, one of the four state banks would step in to provide loans for a deal of this size. However, their reluctance may reflect a growing concern about profitability over government mandates, rather than a lack of high-level support.

7. Strong Government Support. From a strategic viewpoint, it is highly likely the government will support this acquisition because in the long run, it will improve China's current agricultural technology in a meaningful way. In addition, the market expects that the Chinese government might start a new round of industry consolidation upon the completion of this acquisition. But this gets back into the issue of Sinochem's position and whether it is willing to give up a key deal that will establish ChemChina globally, particularly given Sinochem's Chairman Frank Ning's position on Xi Jinping's corruption board, the CCID.

We think the deal will go through. But there are some hairy steps to get there.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.